What Does a 1099 Short Sale Mean?

Unemployment and depressed home values have burdened American homeowners over the past few years, resulting in a historic increase of home loan defaults. The lending industry has responded to the crisis by negotiating strategies with defaulting borrowers that include the settlement of their outstanding loans through a “short sale.”

Home Loan Default

When home prices were appreciating, owners who sold their homes paid off the balances on their outstanding loans and pocketed any surplus as profit. In California, the seller’s trust deed includes a “due on sale” clause that pays the lender the outstanding balance of the loan before other sales-related costs are distributed. Any money that remains is the seller’s to keep as his profit. In this depressed housing market, however, a property will likely sell for less money than what is required to pay off the loan. The seller would be obligated to pay the difference between the sales price and the outstanding loan balance to the lender. Unfortunately, recent economic woes have left many Californians unemployed and unable to pay their monthly home loan obligations. Unable to sell their homes and pay any shortfall to their lender, they consequently face foreclosure.

Short Sale

Many lenders prefer to work with their defaulting borrowers by agreeing to sell the properties as “short sales” rather than sell them at auction as foreclosures. Although short sales are cumbersome and take time to complete, lenders prefer them to foreclosures. The cost of foreclosing on properties is high, and lenders risk the added expense of taking ownership of them as REO (Real Estate Owned) properties in the event that they fail to sell. Lenders then incur the additional expenses of maintaining them, as well as the cost of marketing and selling them at a later time. After a short sale, lenders accept the money from the sale even though it will be “short” of the amount required to pay off the loan. By accepting short sale proceeds, lenders cancel the balances of the debt.

IRS Filing

In accordance with prevailing federal statutes, a lender must issue Form 1099-C, Cancellation of Debt, to a borrower by noting the forgiven amount in box 2 of the form. The borrower must include that amount on his federal income tax return and attach Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. If the deficiency amount is canceled after a short sale, only line 1c and 2 need be completed. If the loan is restructured by the lender, however, and the borrower is allowed to remain in the property, line 10b must also be completed.

Mortgage Debt Relief Act of 2007

Although a canceled home mortgage debt is a relief to borrowers who are unable to make their monthly mortgage payments, the requirement to pay income tax on the forgiven amount might be troublesome if it were not for the Mortgage Debt Relief Act of 2007. The law allows married taxpayers filing jointly to exclude up to $2 million ($1 million if single or married filing separately) of the income derived from the discharge of the debt on a principal residence, beginning in 2007 through 2012.

Section 580b

Although many borrowers were relieved to have shed their unmanageable home loans through short sales, they were often sued by their lenders for a deficiency judgment on the outstanding balances that a short sale did not cover. Under California Code of Civil Procedure, Section 580b, however, California borrowers cannot be sued by their lenders for a deficiency judgment on purchase-money loans that were not paid off by a short sale.

About the Author

Ray Anderson is a professional freelance writer who was the monthly real estate columnist for the “Northern Virginia” magazine and the weekly business columnist for the Maryland-based “Metropolitan Tribune” newspaper. He has written for internet websites and has developed business literature for different companies. Anderson is a licensed Virginia real estate broker and licensing instructor who studied electrical engineering at the University of Maryland.